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Potential changes to alternative minimum tax and donations of publicly listed securities may impact your future charitable giving

Potential changes to alternative minimum tax and donations of publicly listed securities may impact your future charitable giving

Synopsis
3 Minute Read

The 2023 federal budget proposed changes to the alternative minimum tax (AMT) that could impact how high-income individuals donate to registered charities moving forward.

The proposed changes include increasing the income inclusion of capital gains, limiting tax credits, and increasing the AMT exemption and tax rate. Under the new rules, high-income individuals are more likely to be subject to the AMT, especially those who claim significant tax credits or donate capital property to a registered charity.

In this article, we walk through three case studies to investigate how the changes may impact charitable giving in 2024 and beyond — and what you should discuss with your advisor before making any donations.

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Senior Manager

Case studies in this article contemplate only the federal taxes and are for illustrative purposes only. You also need to account for provincial taxes and any mitigating circumstances when considering your specific situation. We recommend conducting any simulations with your MNP tax advisor for the most accurate results.

The 2023 federal budget (Budget 2023) proposed changes to the alternative minimum tax (AMT) that could have a consequential impact on donations to registered charities made by high-income individuals in the future. If enacted, these could apply to Canadian taxpayers in taxation years beginning after 2023. 

What is AMT?

The AMT is an alternative method for calculating the income tax individual taxpayers owe in Canada. 

Each year, individual taxpayers calculate their taxes owing using the normal method, which considers preferential tax deductions and credits, such as the deduction for Canadian Exploration Expenses and dividend tax credits. That result is then compared to a second calculation where the individuals generally do not receive these preferential tax deductions and credits, but their tax is calculated at a lower rate. 

For most individuals, the first calculation will result in more taxes payable; this is the tax they will pay for the year. However, if the second calculation results in more taxes payable, the individual will pay that amount. 

The difference between the lower amount of taxes payable calculated using the normal method and the higher amount calculated using the second method is called the AMT. 

For practical purposes, the AMT is a prepayment of tax. An individual can generally use the amount of AMT as a credit against regular taxes payable for the next seven years — provided they pay sufficient income tax based on the normal method of calculation in the year they wish to apply the credit.

Case study: The current landscape

To illustrate how AMT works, consider Ms. F, an individual taxpayer with a substantial investment portfolio with a mix of personal investments and investments held by a wholly owned investment holding company. 

Ms. F earned income from her $1.357 million investment portfolio in 2022 and calculates she owes approximately $430,000 in federal tax using the normal method. The second calculation reveals there is no AMT. On this basis, Ms. F simply pays the federal tax calculated using the normal method.

But what happens if Ms. F wanted to make a large charitable contribution that same year? While she could sell her publicly listed securities and donate the cash, it’s more tax efficient to donate the securities directly. If the donated publicly listed securities had a fair market value of $750,000, that would result in a capital gain of $500,000.

Therefore, Ms. F would reduce her federal tax owing to approximately $183,000 using the normal method.  There would be no capital gains tax when donating the publicly listed securities. She would also have a donation tax credit to offset taxes otherwise owing.

Using the second calculation, Ms. F would have no AMT owing either.

Proposed changes

Budget 2023 and the subsequent draft legislation introduced on August 4, 2023, propose changes which, if enacted, could result in AMT applying more broadly for taxation years that begin after 2023.

Some of the key proposed changes impacting income for AMT purposes include:

  • 100 percent income inclusion of capital gains (compared to 80 percent under current AMT rules).
    • The current exemption for capital gains realized on donations of capital property will be eliminated.
    • An exception remains for capital gains realized on donations of publicly listed securities, to which a 30 percent income inclusion rate will apply (compared to 0 percent under current rules).
  • 50 percent inclusion rate for capital loss carry-forwards (reduced from 80 percent under the current AMT rules).
  • Limitation of non-capital loss and limited partnership loss carry-forward deductions to 50 percent (reduced from 100 percent under the current AMT rules).
  • Limitation of certain expense deductions (e.g., interest on money borrowed to earn income, moving expenses, childcare expenses) to 50 percent.
  • Limitation of most non-refundable tax credits (including the donation tax credit) to 50 percent.

Further, the legislation proposes to increase AMT exemption for individuals from $40,000 to an amount indexed to the fourth tax bracket ($173,000 estimated for 2024). The AMT tax rate is also proposed to increase from 15 percent to 20.5 percent.

The proposed changes will generally increase the likelihood that high-income individuals will be subject to paying the AMT — especially those that claim significant tax credits (e.g., donations) that reduce their taxes payable or donate capital property (e.g., publicly listed securities) to a registered charity.

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Case study: Impacts of the proposed changes

Consider, again, Ms. F, who donated publicly listed securities that resulted in a capital gain of $500,000 and would have no AMT before the proposed changes.

The proposed changes contemplate, among other things, that most non-refundable tax credits (including the donation tax credit) will be limited to 50 percent of the tax credit available for regular tax purposes. Moreover, 30 percent of the capital gains on donations of publicly listed securities will be included in the AMT base, as opposed to none under the current regime.

If the changes are enacted as currently proposed, and Ms. F donates after the fact, she will owe approximately $55,000 in AMT. Still, with proper planning, she may be able to recover this AMT if she has taxable income in the next seven years. 

What this means for taxpayers

Given the potential impacts, individuals planning to make a personal charitable donation in the near term may wish to do so in the 2023 calendar year — before any potential legislative changes take effect. 

If this is not possible, and the proposed changes are enacted, they should discuss any planned charitable giving with their accountant or tax advisor. 

Case study: What to discuss

Recall that if the changes are enacted, Ms. F will need to plan for increased AMT in the year she makes the donation and how she will pay that increased tax. But she may still be able to recover this AMT over the next seven years. She should discuss with her tax advisor the planning steps required to do so.

Moreover, Ms. F should know that AMT applies to individuals. She should also discuss whether it makes sense to consider corporate rather than personal donations.

Corporate donations have the same benefit of a null inclusion rate on the capital gains realized on the donation of publicly listed securities. They can, therefore, be a great way to continue supporting registered charities. Corporate donations can also have additional tax benefits that Ms. F may wish to discuss with her tax advisor.

Conclusion

Proposed changes to the AMT will significantly impact the donation options available to high-income-earning taxpayers. The good news is that you can continue to make impactful charitable donations to registered charities while maintaining tax efficiency, even if the rules come into effect as proposed.

Your best course of action, regardless of the AMT regime moving forward, is to discuss any large-value donations with your tax advisor before initiating the transaction. This will ensure that your generosity is not detrimental to your financial well-being.

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